If you’re nearing retirement, you’ve probably had a conversation with some advisor pitching an annuity. But the big question is, “Should you buy an annuity for steady income, or should you hold off on Social Security to boost your monthly check?” Both options create a “retirement paycheck,” but which one is right for you? Let’s break down each choice to help you feel confident about your decision.
Social Security vs. Annuities: What’s the Difference?
Social Security
Social Security is a monthly government benefit that lasts a lifetime and adjusts for inflation each year. The longer you wait to start it—up until age 70—the higher your monthly check. Waiting adds about 7-8% more to your monthly benefit each year.
Income Annuity
An annuity, specifically a Single Premium Immediate Annuity (SPIA), is an insurance product where you buy yourself a pension with a lump sum, providing you with steady lifetime income. However, unlike Social Security, annuities don’t automatically adjust for inflation, so your monthly check remains the same over time.
* In this post, if you read annuity or income annuity, I am referring to this type of annuity.
Advantages of Social Security Over Income Annuities
Inflation Adjustments
Social Security benefits automatically increase each year to keep up with rising prices, maintaining purchasing power.
Annuity payments, however, are usually fixed and lose value over time as costs go up.
Tax Treatment
Social Security benefits are often more tax-friendly; only up to 85% of Social Security income is taxable, and this varies with your overall income.
Some states don’t tax Social Security benefits at all, adding another layer of savings.
Meet Donald: A Case Study
Donald, age 62, has $500,000 saved in a 401(k). 60% stocks and 40% bonds. He’s deciding between three options:
Start Social Security now at $2,030 a month and use his 401(k) savings as needed.
Buy an annuity with $250,000 of his 401(k), providing $1,502 of monthly income, and start Social Security immediately at $2,030 a month.
Tip: Always buy income annuities from insurance companies rated A+ or better.
Delay Social Security until 67 for a benefit of $2,900 a month, using his 401(k) savings in the meantime.
We ran some calculations to see how each choice would impact his retirement. Here’s what we found.
What the Numbers Showed
Income Annuities Outperformed the Base Case Sometimes
When income needs were lower income annuities outperformed the base strategy of starting Social Security early and relying on the portfolio.
Delaying Social Security Wins in Almost All Cases
If Donald needed a higher income (say, $4,700/month), delaying Social Security provided much better financial security. Social Security’s inflation adjustments and tax benefits made this option a clear winner.
Annuities Weren’t a Bad Option for Lower Income Scenarios
If Donald’s income needs were lower (around $3,800/month), the annuity option was in line with delaying Social Security. However, it’s important to remember that annuities don’t adjust for inflation. So, while it might work for the short term, its spending power would likely drop over the years as the cost of living rises.
Why Delaying Social Security First is Often the Best Bet
In most cases, delaying Social Security until age 67 or even 70 is a smart move before considering an annuity. Social Security’s inflation protection, guaranteed lifetime income, and favorable tax treatment make it hard to beat.
There is rarely a substantial benefit to an income annuity over delaying Social Security, which is why delaying Social Security is often the first recommendation.
That said, annuities can still play a role in retirement planning. If you’ve delayed Social Security as long as possible and still want additional guaranteed income, an annuity may be worth considering.
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